Externally China’s economy continues to be struck with great force by the current collapse in world trade produced by the international financial crisis. China’s April exports were down 22.6% compared to a year earlier. This is a lesser fall than for most countries but necessarily applies severe contractionary pressure to China’s economy.
Internally the Chinese government’s stimulus programme has led to a 30.5% rise in investment in fixed assets in the first four months of 2009 – an increase from the 28.6% year on year increase in the first quarter. Simultaneously China's retail sales in the year to April grew by 14.8%.
The result of the contradictory impact of the negative pressure from the decline in export, and the positive one from internal economic expansion, was the 7.3% year on year increase in industrial output to April. This is relatively low by China’s recent standards but stellar by those of almost all other countries which are suffering major declines in industrial production.
As China’s investment is rising more rapidly than consumption the share of investment in China’s GDP is necessarily rising. While precise quantitative data on the composition of GDP will not be available for some time nevertheless it is possible to judge orders of magnitude.
If it is assumed that China’s overall consumption rises at the same rate as retail sales (which is probably on the high side but no alternative objective measure is available at present),and that retail sales and investment continue to rise for the rest of the year at the same rate as in the first four months, while it is simultaneously assumed the balance of payments surplus declines by 30%, then this implies fixed investment would rise from 43% of China’s GDP in 2007 to approximately 46% in 2009. Evidently there are a considerable number of assumptions in such an estimate regarding trends in the rest of the year but it gives a rough yardstick.
Calculations done by Jing Ulrich, chairwoman of China equities at JP Morgan in Beijing, give a slightly lower estimate - that at present rates of growth investment will account for 45% of China’s GDP this year. Whatever the exact final outcome, therefore, it is clear that the share of investment in China’s GDP is rising.
In the present circumstances this has necessary consequences for China’s balance of payments surplus – given that such a surplus is necessarily equal to the surplus of domestic savings over domestic investment.
It is wholly unlikely that China's total savings level is rising at present given that the state budget is projected to move from balance to a 3% deficit this year, and company profits, the main source of China’s high savings level, are falling as a proportion of GDP under the impact of the financial crisis. China this year will at best have the same savings level as last year, or more probably its savings rate will decline somewhat.
As China’s savings rate is static or falling, and investment is rising, this implies a fall in China’s balance of payments surplus during 2009. China’s broader balance of payments figures will not be available for some time but balance of trade figures are available to April - and the trade balance dominates China’s overall balance of payments position.
The trade figures indicate that China’s monthly trade surplus fell from a peak of $40.1 billion in December to $13.1 billion in April. This figure, however, does not take into account seasonal fluctuations and a comparison with April last year shows a smaller reduction from $16.7 billion to $13.1 billion. The trend in the balance of payments surplus at present, however, is downwards. China’s balance of payments surplus, in short, is likely to fall as domestic investment rises.
This development may be sharply contrasted to the course advocated by Martin Wolf, and others, that China should close the gap between its savings and investment levels primarily by cutting its savings level rather than increasing its investment rate. As has been frequently pointed out on this blog there is a clear factual, as well as theoretical, positive correlation between a high rate of investment and a high rate of growth. China’s economy would slow if it were to reduce its investment rate – something which is not merely undesirable from the point of view of China but, particularly given the present international financial circumstances, is also highly undesirable from the point of view of the world economy. The present course of the Chinese government, which is increasing China’s investment rate, is therefore far preferable to the course advocated by Wolf not only from the point of view of China but from the point of view of the world economy.
Regarding China’s balance of payments surplus itself, while China requires a high rate of investment for a high rate of economic growth there is no reason to be found in economic theory, nor is there any evidence to suggest, that a high balance of payments surplus is any sense a precondition for rapid economic growth. Indeed, as a balance of payment surplus necessarily means that resources are not being productively invested in China, but are being invested in US Treasury bonds, it would be preferable, and secure a higher rate of return, for China to productively use a larger proportion of its assets within China – or put in other terms, the preferable way for China to use its high savings rate would be to increase its domestic investment rate from its previous level.
The argument that has appeared in sections of the foreign language media that China should not increase investment because this will increase ‘overcapacity’ is entirely fallacious theoretically. A high level of investment does not consist in creating more production capacity of the same type at the same levels of technology, efficiency, or productivity – the proposal that China should create more low value added production capacity is evidently false. The issue is high investment to upgrade China’s economy technologically and in terms of productivity and efficiency. Moreover, factually, China is at the beginning of this upgrading of its investment capacity. Capital stock per US worker or per West European worker is very much higher than per Chinese employee. To overcome this lag requires that the investment stock per Chinese worker rise more rapidly than in the US or Europe for a prolonged period.
In addition to direct investment in the workplace the efficiency of any economy, its level of productivity, does not rely only on extra machinery but on the efficiency of a country’s entire productive system including transport, communications, education etc. China has many decades of rapid investment to go through not only in machinery but in infrastructure before its level of capital stock, and therefore overall economic efficiency, even remotely approaches that of the US or Europe. This is merely another way of stating that, in order to achieve the technological and productivity level of the US and Europe, China must go through many decades in which its rate of growth of investment must exceed that of the US and Europe.
Nor, contrary to what is sometimes argued, is a high rate of investment contrary to the environmental needs of China – the exact opposite is true. Environmentally protective policies, for example low carbon emission power generation, is likely to be more expensive than environmentally damaging technology in the short term - although not necessarily in the longer one. To maintain a high level of economic growth in an environmentally protective fashion will therefore require a higher level of investment in China to maintain the same rate of growth – although such investment, of course, will not be in the same technologies as at present.
Increasing its level of investment, therefore, means the technological and productivity upgrading of China – both in terms of immediate productive capacity and the other indirect forms of investment supporting it, and not a merely quantitative expansion of existing technological and productivity levels. In short the argument that extra investment is wrong because it will create ‘overcapacity’ is entirely economically fallacious.
Purely abstractly, from a financial point of view, the highest possible utilisation of China’s savings for a still higher investment within China itself is desirable – which of course, as a by-product, would eliminate the balance of payments surplus. However such abstract financial considerations are subordinate to more practical constraints.
First, in the medium and long run the population of China will gain most from a high rate of economic growth, which requires a high level of investment. That is, the gain in sustainable consumption, both individual and social, which flows from a high growth rate and high investment level exceeds that which would be gained from increasing the share of consumption in GDP. Nevertheless such medium and short term gains must be balanced against short term consumption – with the key criteria being the welfare of the population and therefore its support for the economic system which has brought such success.
Second the rate of investment must be used to upgrade environmentally protective technologies and to replace, not expand, environmentally damaging ones.
Third handling very large investment programmes is not merely a question of allocation of finance but involves material organisation of the economy. As the author is aware of not only from theory but from experience of dealing with large infrastructure projects in London it is considerably easier to make allocations of finance than it is to ensure the efficient delivery of very large scale investment programmes. Whether China possesses the capacity to achieve the latter on any specified scale is a concrete issue that only those in the centre of the relevant economic decisions making have the information to take. Furthermore social, as well as strategic economic growth decisions, must be taken into account.
From an overall financial point of view under the conditions that prevailed in the first half of 2008 prior to the financial crisis, when the Chinese economy faced over- heating and rising inflation, it would, of course, have been dangerous and irresponsible to increase investment further. But now China’s economy is faced not with overheating but an international economic downturn and a potential, if not yet extremely serious, threat of domestic deflation rather than inflation – China’s consumer price index fell by 1.5% in the year to April and its producer price index fell by 6.6% in the same period. Under those circumstances an increase in the rate of investment does not pose the threat of overheating.
China’s investment surge is therefore not only good for its own economy but good for the world economy. Those, such as Martin Wolf, who proposed an alternative course that China should reduce its savings and investment rates were dangerously wrong.